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The amazing shrinking Telecom

By Shoeshine

Friday 27th June 2003

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Well-flagged though they were, Telecom's announcement of three giant outsourcing deals in as many days has market analysts scratching their heads.

Even its big international investors don't seem to know quite what to make of the telco's striptease act.

Franklin Resources and Deutsche Australia have been selling down. Los Angeles-based Capital Group has soaked up 20 million shares over the past three months at an average price of $4.48, taking it to 6.04%.

This has no doubt contributed to the three-month rally that has carried the stock up 26% from its low of $4.11. In turn that will have helped the NZSE50 rally that has added hundreds of millions to investors' portfolios and will have come as a big relief to embattled fund managers.

Telecom now seems to be taking a breather as the market digests the scant detail on its outsourcing contracts.

The three deals, all for a five-year period, are together worth $380 million and have been several years in the making.

The first deal, announced last Thursday, sees supply and management of Telecom's 027 3G mobile network outsourced to Lucent Technologies, which built the network 18 months ago. The price tag is $200 million and Telecom said the deal would lower costs but declined to say by how much.

The most significant aspect of the deal is that Lucent takes over responsibility for capital expenditure on the network, freeing up Telecom's cashflow for faster debt repayment.

The company is keen to start boosting the dividends it cut three years ago but has to meet banks' debt ratio targets first.

Deal number two, announced the next day, was the $120 million outsourcing of the management of the New Zealand wireline network, including design, operation and support.

The agreement extends the "network partnering agreement" signed a year ago, under which Alcatel would help migrate Telecom's legacy networks on to IP (internet protocol) on both sides of the Tasman and would supply all the equipment. Negotiations for that agreement started in November 2001.

Deal three, unveiled on Monday, saw the Alcatel agreement extended across the Tasman to subsidiary AAPT's existing and new networks.

Press releases for all three trumpeted the "cutting-edge services" the agreements would allow the telco to deliver to customers.

All three deals are also expected to save it money but the market will have to wait to see just how much. The only indication so far is that about 350 staff, from the total of 6906 the company reported last June, will move over to Lucent and Alcatel.

The latest crop of outsourcing continues Telecom's shedding of successive shells of cost as it evolves toward a sales and marketing organisation with only an elite team of executives running things at the top.

It sold network design, build and maintenance subsidiary Connectel to Downer Group back in 2000 and has since sold mobile radio operator Teamtalk and outsourced IT systems management to EDS and the 2G mobile network to Ericsson.

The moves have been showing through in strong cost reductions, which have cushioned the effect of weakening revenues.

These were particularly strong in the March third quarter. Overall operating costs shrank by 5.4% while revenue rose 1.4%.

The cuts came across the board with the exception of internet and directories.

While all this is great news for Telecom shareholders it does nothing for our home-grown telecommunications software and equipment makers, among which are some veritable hothouses of innovation.

In bigger economies with several major domestic telcos, such companies get a leg-up by selling to the local firms, providing them with the crucial reference sites to enable them to take their products to the international market.

Telecom's deals put multinationals such as Alcatel and Lucent in charge of sourcing all this stuff and they import the product used by their global parents. New Zealand up-and-comers are dismissed as "too small" and are politely shown the door.

An encouraging exception, albeit in a different field, is Auckland-based Gen-i, which this week won a $50 million, four-year IT outsourcing contract with Insurance Australia Group, now the country's biggest general insurer.

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